Jackson says there are over 55,000 taxable municipal issues, offering vastly more selection than a corporate bond index, but it’s a difficult bond pond to fish from because each issuer is dealing with their own budgetary and labor issues. Still, USAA has allocated 5% to 10% of the assets in its investment-grade funds to taxable municipal bonds.
Taxable munis are also a source of stability for his portfolios, as municipal issuers cannot be the target of a leveraged buyout, and the 10-basis-point default rate for municipal bonds in general carries over to the taxable realm.
“We think you get compensated many times over for infinitesimal and low default rates,” he said.
USAA has also been adding structured asset-backed securities in the credit card and auto loan space, said Jackson, because they come at a lower price than investment-grade A-rated corporate bonds.
Looking across the corporate space, Jackson said that USAA has no broad credit concerns and does not expect a significant downgrade cycle. He also predicted that defaults will continue to wane.
“Last year was a blowout year in issuance. The amount of bonds issued by corporations was up on the order of about 50%, and a lot of that cash was just put on the balance sheet,” he said. “There were companies issuing debt and raising cash because of the level of uncertainty in March, April and May. It was extremely high. The question now is what companies do with that excess cash and what that means for credit quality.”
Jackson foresees that excess cash being used for acquisitions and share buybacks, where applicable, but also to pay down debt.
USAA’s bond portfolios are built from the bottom up with industry-by-industry, issue-by-issue underwriting. When they build fixed-income portfolios, its managers focus more on credit spreads and potential risk than macro questions like the direction of interest rates, the shape of the yield curve, GDP forecasts or Fed-watching.
“Each month we have a scheduled cycle where we look at the relative value of all the corporate credit sectors, where they’re pricing relative to the general corporate market, and where they’re pricing relative to debt in individual sectors,” said Jackson. “We also look at credit spreads over one-, five- and 15-year periods to determine if we’re being compensated more or less for taking risk than we have been historically.”
USAA uses this process to determine which sectors are expensive or inexpensive relative to both each other and to themselves through history.